Is Your Investment
Fund a Ponzi Scheme?
Regina M. Alter, Esq. – Butzel Long, P.C. – alter@butzel.com
Joshua E. Abraham, Esq. – Butzel Long, P.C. – abraham@butzel.com
Neil Steinkamp, CVA, CCIFP, CCA – nsteinkamp@srr.com
Introduction n n n
nOver 1,000 total years of sentences were
handed down in 2013 to at least 117 individuals
involved in Ponzi schemes.
The Second Circuit Court of Appeals has defined a Ponzi
scheme as:
nMales were the predominant perpetrators, constituting
approximately 90% of the individuals sentenced.
a scheme whereby a corporation operates and continues
to operate at a loss. The corporation gives the appearance
of being profitable by obtaining new investors and using
nThe total dollar amount of all Ponzi schemes in
2013 exceeded $13 billion.
those investments to pay for the high premiums promised
to earlier investors. The effect of such a scheme is to put
the corporation farther and farther into debt by incurring
more and more liability and to give the corporation the false
appearance of profitability in order to obtain new investors.
Hirsch v. Arthur Andersen & Co., 72 F.3d 1085, 1088 n.3 (2d
Cir. 1995).1
No reasonable investor would purposely invest in a fraud, yet
many times even sophisticated investors are unable to recognize
the signs that an investment opportunity may in fact be a Ponzi
scheme. In reality, Ponzi schemes are more prevalent than most
While Ponzi schemes are inherently deceptive, extremely
complex, and can be very difficult to observe as an investor or
outsider, there are signs that may be spotted by a cautious and
careful investor willing to engage in the appropriate level of due
diligence. This article provides insight to sophisticated investors
by discussing the hallmarks of a Ponzi scheme, reviewing recent
enforcement activity, discussing the risks sophisticated investors
often face in investing in a Ponzi scheme, and looking at a case
study illustrating the challenges of identifying a Ponzi scheme and
the red flags often associated with them.
realize and many investors often simply abide by the theory that
“it won’t happen to me.” According to Ponzi Tracker:2
See also Janvey v. Alguire, 647 F.3d 585, 597 (5th Cir. 2011) (“A Ponzi scheme is a
fraudulent investment scheme in which money contributed by later investors generates
artificially high dividends or returns for the original investors, whose example attracts
even larger investments.”) (citing Black’s Law Dictionary 1198 (8th ed. 2004); In re
M & L Business Mach. Co., Inc., 84 F.3d 1330, 1332 n.1 (10th Cir. 1996) (“We have
defined a Ponzi scheme as an investment scheme in which returns to investors are not
financed through the success of the underlying business venture, but are taken from
principal sums of newly attracted investments. Typically, investors are promised large
returns for their investments. Initial investors are actually paid the promised returns, which
attract additional investors.”) (internal citation omitted).
2
http://www.ponzitracker.com/main/2013/12/23/2013-ponzi-schemes-in-review-nearly3-billion-of-ponzi-schem.html.
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nAt least 67 Ponzi schemes were exposed in 2013.
nThe average Ponzi scheme was approximately
$44 million.
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Recently Revealed Ponzi Schemes n n n
medical accounts receivable to hedge funds and other
investors.9
nMichael Stewart and John Packard, the chief executives
nGregory Podlucky, the former CEO of Le-Nature, a
bottled water manufacturer, received a 20-year prison
sentence for his orchestration of a $685 million “loanPonzi” scheme that defrauded lenders and investors
by falsely inflating the company’s financial strength
and business activity.10
of Pacific Property Assets, were charged by the FBI with
11 counts of mail and wire fraud, three counts of bank
fraud, and two counts of bankruptcy fraud for allegedly
turning PPA into a Ponzi scheme after the 2007 real
estate market collapse. The pair allegedly began raising
new funds post-real estate crash to pay off their pre-cash
investors, lenders, and creditors.3
nDoris Nelson was charged in January 2013 with
conducting a $135 million Ponzi scheme by soliciting
investors across the U.S. and Canada to fund her
short-term loan business, the Little Loan Shoppe. Ms.
Nelson allegedly advertised the loans she made were
insured and “risk-free” when in reality the loans she
made defaulted at an unsustainable rate.11
nBrent Williams and his son were convicted for conducting
a $100 million Ponzi scheme. The pair operated Mathon
Entities and solicited funds from members of the Church
of Jesus Christ of Latter-day Saints by promising high
returns on short-term loans.4
nShirley Sooy was charged in early 2013 with
nThe heads of two companies operating under the names
“CKB” and “CKB168” were charged with operating a $20
million Ponzi scheme by marketing the company as a
profitable distributor of web-based children’s educational
courses. CKB raised over $20 million from U.S. investors,
mostly Asian-Americans, and millions more world-wide.5
nEdwin Yoshihiro Fujinaga was charged with an $800
million Ponzi scheme purportedly targeting Japanese
investors through MRI International Inc. Yoshihiro allegedly
claimed that the funds raised would buy discounted
medical accounts receivables (MARs) from medical
providers that would be turned around and sold to
insurance companies for full value.6
nBrian Dinning received a sentence of 12.5 years in 2013
for masterminding a $2.5 million Ponzi scheme. The
scam claimed funds would be invested in South African
real estate, gold, and diamond mines where some of the
returns earned would be donated for wildlife conservation
and missions in South Africa.7
nAdam Jay Boskovich and Gerard Cellette were charged
with allegedly running a $150 million Ponzi scheme in
California without having stepped foot in the state using
the company Minnesota Print Services Inc. The pair
attracted investors by falsely portraying the company’s
contracts and services.8
conducting a $42 million Ponzi scheme by comingling
collected money from victim companies that was to
be used for freight bills and misappropriating millions
of dollars of trust funds in the process.12
Hallmarks of a Ponzi Scheme
There are two requirements typically necessary for a Ponzi scheme
to be successful in the short run: (i) the scheme must be able to
continually attract investments into the fund or business; and (ii)
the scheme must be able to operate in a manner which conceals
from regulators and investors its use of incoming investors’ funds
to pay existing liabilities.. Because of this, Ponzi scheme operators
tend to be extremely secretive with respect to their investment
methods and business dealings. Indeed, a common ex post
discovery is that many Ponzi schemes take great care to obscure
and otherwise falsify their books and records, rendering the typical
pre-investment considerations irrelevant. This of course begs the
question: How does one know whether an investment opportunity
may actually be a Ponzi scheme?
There are several common characteristics and “red flags” that
could be indicative of a Ponzi scheme:
nThe Promise of Lofty and Consistent Returns:
Ponzi schemes will often promise lofty returns or
even normal but guaranteed returns, typically within
a short timeframe. For Ponzi schemes to attract
the necessary investments with as few questions as
possible they will often lure initial contributors with
nJonathan Rosenberg and Richard Shusterman were
indicted for allegedly perpetrating a $275 million Ponzi
scheme through three separate companies. The pair
allegedly enticed investors with the opportunity to re-sell
http://www.fbi.gov/losangeles/press-releases/2014/founders-of-bankrupt-socal-real-estate-investment-firm-indicted-in-wide-ranging-scheme-that-led-to-more-than-110-in-losses.
“Former Employee of Deceased Friendswood Financial Advisor Convicted of Running Own Ponzi Scheme,” The Federal Bureau of Investigation, 19 February 2013.
http://www.ponzitracker.com/main/2013/10/17/sec-stops-20-million-pyramid-scheme-touting-youth-education.html.
6
http://theponzibook.blogspot.com/2013/10/october-2013-ponzi-scheme-roundup.html.
7
http://hamptonroads.com/2013/10/exlawyer-gets-prison-south-african-ponzi-scheme.
8
http://www.ocregister.com/articles/cellette-533004-million-county.html.
9
“Former Employee of Deceased Friendswood Financial Advisor Convicted of Running Own Ponzi Scheme,” The Federal Bureau of Investigation, 19 February 2013.
10
http://www.justice.gov/usao/paw/news/2011/2011_october/2011_10_20_03.html.
11
http://www.ponziclawbacks.com/tag/doris-nelson/.
12
http://www.nj.com/somerset/index.ssf/2014/05/former_nj_woman_accused_of_running_multi-million_ponzi_scheme.html.
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high potential returns. Next, the perpetrator will initially
actually deliver (or purport to deliver) on these promised
returns, in order to establish credibility and solicit
additional investors. Unfortunately, this type of attraction
works better if the perpetrator is known in a particular
small knit community and presumed trustworthy. Indeed,
affinity, or targeted fraud is one of the most common
methods utilized by scammers.13 From an aware
investor’s standpoint, if it seems too good to be true,
it probably is.
products mature and evolve in complexity, Ponzi schemes
nLimited Access to Information: Ponzi schemes will
by complaints made by three Louisiana public pension funds (the
also limit investor access to information regarding the
strategies and operations of the business and may
provide vague indications as to how the money
is invested.
“Pension Funds”) that had tried unsuccessfully to redeem their
nInability to Replicate Returns: The stated returns
are often significantly higher than those of other similar
investments and/or there are inconsistencies or highly
unusual explanations about the methods generating
the returns.
will similarly grow in size and sophistication. Potential victims,
however, can do a lot to avoid these fraudulent investments.
A Case Study
On June 29, 2012, Fletcher Asset Management (the “Fletcher
Funds”), a group of hedge funds run by a well-known fund
manager, Alphonse “Buddy” Fletcher, filed for Chapter 11
protection in the Bankruptcy Court for the Southern District of New
York. The Chapter 11 filing was allegedly brought about, in part,
more than $100 million investment in the Fletcher Funds and then
retained Ernst & Young to investigate the Fletcher Funds’ books
and records. The Fletcher Funds proposed to satisfy the pension’s
redemption requests with promissory notes rather than cash,
which raised alarms with the Pension Funds.
The eventual Chapter 11 bankruptcy Trustee identified numerous
alleged irregularities with respect to the Fletcher Funds in a
formal report and disclosure statement (the “Fletcher Report”) —
nProfessional Services: A firm’s auditor or administrator
allegations that are illustrative for helping sophisticated investors
is known to be related to the principle of the fund, or is
atypically small and incongruently providing services to a
fund with significant assets under management.
determine the legitimacy of new investment opportunities. The
Trustee noted in the Fletcher Report that “the fraud here has
many of the characteristics of a Ponzi scheme where, absent new
investor money coming in, the overall structure would collapse.”
From the Inside – What We Learned From
According to the Fletcher Report, the Fletcher Funds reported no
Madoff, Stanford, and others
down months for a 127 month period from June 1997 through
Ponzi schemes, while simple in theory, have grown more
complex as worldwide investment barriers continue to fall and
an ever-growing cadre of sophisticated investors seek higher
returns (while willing to sacrifice rationality) in a low interest rate
environment. R. Allen Stanford, for example, who purported to sell
high-yielding certificates of deposit, was based in Houston, Texas,
but controlled and operated banking institutions and investment
accounts in Antigua and Europe. Madoff was based in New York,
but his operations spawned an array of actual and synthetic
“feeder funds” located across the globe. Many of Stanford’s and
Madoff’s victims were U.S.-based, but many were also high networth individuals and funds located in Central America, South
America, and Europe. The majority of Stanford’s and Madoff’s
victims believed they were investing in safe, but consistently highyielding products or strategies.
Recent years have also seen larger Ponzi schemes than in years
past. Stanford is estimated to have defrauded investors of $2-$7
billion and Madoff operated what is believed to be a $19 billion
fraud (or a $65 billion scheme if fictitious profits are included) —
the largest recorded Ponzi scheme to date. As capital continues to
flow internationally toward high yield opportunities, and financial
13
December 2007 even though the Fletcher Funds’ investment
thesis was to invest in private investments in public equities
(“PIPE”) whose values are correlated to the equity markets, which
themselves had seen many ups and downs during that same 127
month period.
Moreover, the Trustee claims to have found that the values which
the Fletcher Funds placed on its investments were “wildly inflated”
to fraudulently generate more than $30 million in fees and attract
new investors. Although the Trustee identified many structural
and operational issues related to the Fletcher Funds, the portfolio
valuation process bears discussion starting with the Fletcher
Funds fee structure, which was not typical of a private equity
fund. According to the Trustee report, the Fletcher Funds’ fee
structure charged weekly fees on realized and unrealized gains.
This structure would be unusual for a private equity fund with
an investment strategy to acquire investments which may have
liquidity restrictions. By virtue of a PIPE being a private investment,
investors hold unregistered securities of the issuer at closing and,
depending on the PIPE offering, an investor may or may not have
the right to register his or her shares for sale to the public market.
The typical fee structure for a fund holding illiquid investments is to
charge investors quarterly based on invested capital and realized
Christopher T. Marquet, The Marquet Report on Ponzi Schemes: A While Collar Fraud Study of Magor Ponzi-Type Investment Fraud Cases Revealed from 2002-2011, MARQUET
INTERNATIONAL (2 June 2011).
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gains. This typical structure ensures a “cash on cash” return for the
investor and that the manager and investor are on equal footing
when investment returns are paid out. A fee structure in which the
fund manager is paid before the investor may create an incentive
Enforcement Highlights
The threat a Ponzi scheme poses is not just that an investor will
lose its invested capital when the scheme collapses, but that an
for the manager to inflate the value of the fund investments.
investor who withdrew any return on his or her initial investment
Next, the Trustee identified 10 investments in which Fletcher Funds
to a “clawback” suit — a lawsuit filed by a bankruptcy trustee
allegedly reported “too good to be true” unrealized windfall profits
or receiver to recover funds previously distributed by the Ponzi
on or close to the date in which the Fletcher Funds acquired the
scheme. In order to compensate “net losers” in a Ponzi scheme,
investments. The Trustee reported that the Fletcher Funds marked
bankruptcy trustees will use clawback suits to try to recuperate
these 10 investments at a weighted average of 2.7 times what
“fictitious profits” received in excess of principle from “net
it had just paid for them. Although valued at their highest marks
winners,” regardless of knowledge of the fraud. If the bankruptcy
at $454 million, according to the Trustee, the 10 investments
trustee has reason to believe that the “net winner” knew of or
had a realizable value of only $60 million when they were sold or
should have known of the fraud, the trustee will seek to recover
transferred out of the funds. The Trustee noted that when marking
not just the “net winnings,” but also principal payments made to
its portfolio, the Fletcher Funds primarily relied on mathematical
the defendant.
models (marked to model) and ignored current transaction prices
at which securities similar to the Fletcher Funds’ investments had
recently traded. Using these market indicators — also referred to
as comparable or precedent transactions — as a key valuation
input and a sanity check against mathematical models is a
standard valuation approach for funds that mark their portfolios to
from the initial investments prior to the collapse will be subject
Clawbacks have been used since the 1920s when Charles Ponzi’s
own infamous scheme collapsed, but the use and number of these
types of claims has grown in frequency since the 1980s. This trend
is especially notable in regards to the clawback suits brought
against unaware, innocent investors, who had no knowledge of the
market in accordance with U.S. GAAP.
fraudulent nature of their investment arrangement. For instance,
Interestingly, according to the Fletcher Report, the Fletcher
clawback suits against both institutions and single party investors
Funds did have third-party vendors providing financial services
in an effort to reclaim some of the nearly $20 billion in losses.
to the Fletcher Fund, such as an independent auditor and a
There are, however, limitations for the use of clawbacks that deal
fund administrator who had responsibilities with respect to
with the timeframe in which the bankruptcy trustee may reach
the valuations. According to the Fletcher Report, the outside
back to reclaim profits and the fraudulent assumptions imposed
service providers tended to rely heavily on the Fletcher Funds’
in each of the specific cases themselves.14
own valuations and one such service provider, after receiving an
SEC subpoena and doing an internal valuation of its work for the
Irving Picard, the Madoff bankruptcy trustee has filed over 1,000
As a result of the uncovering of Bernie Madoff’s nearly $20
Fletcher Funds, withdrew its audit opinion.
billion and Allen Stanford’s $7 billion Ponzi schemes, the Federal
Also, surprisingly, the Fletcher Funds used an independent
Securities & Exchange Commission (the “SEC”), the Federal Trade
valuation consultant to validate the periodic valuations of the
Commission (the “FTC”), and the Federal Bureau of Investigation
underlying fund investments. Although use of an outside consultant
(the “FBI”) have joined forces to “root out and expose” Ponzi
to review portfolio valuations would ordinarily provide some level
schemes and other investment scams within the United States. In
of comfort to an investor, the Trustee raised a number of criticisms
the latter half of 2010 the Financial Fraud and Enforcement Task
related to the independent valuation consultant. First, Fletcher
Force (the “Task Force”) concluded Operation Broken Trust which
was the consultant’s only valuation client and the consultant
brought over 211 criminal and civil fraud cases involving over
lacked the necessary knowledge and expertise to independently
$8 billion of direct investment scams. According to their report,
mark the portfolio. Second, the consultant inappropriately applied
the task force opened over 200 Ponzi scheme investigations and
mathematical models with faulty inputs, and failed to check them
identified the top “Ponzi scheme hot spots” to be Los Angeles,
against the market value of similar investments; i.e., mark to model
New York, Dallas, Salt Lake City, and San Francisco.15 Since the
approach. Lastly, the consultant allegedly lacked independence
government crackdown on white collar crime, several notable
in that it received fees for valuation services in excess of typical
Ponzi schemes have come to light.
government and several regulatory agencies including the
market rates for such services and had side business deals with
the Fletcher Funds.
For example, under the Bankruptcy Code, a trustee may recover fraudulent transfers made within two years prior to the bankruptcy petition date. See 11 U.S.C. § 548(a)(1)(A). If the
trustee also sues under state law, the look-back period is larger. For example, under Texas law, fraudulent transfers made within four years of the suit are actionable. See TEX. BUS. &
COMM. CODE § 24.010. Under New York law, the look-back period is six years. See Orr v. Kinderhill Corp., 991 F.2d 31 (2d Cir. 1993); see also N.Y. Debt. & Cred. L. art. 10, §§ 270-281
and N.Y. Civ. Prac. L. & R. § 213(8).
15
“Operation Broken Trust: Historic Investment Fraud Sweep,” The Federal Bureau of Investigation, 6 December 2010.
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Conclusion n n n
Regina M. Alter, Esq. is a Shareholder in the New York office of
Butzel Long, P.C. She concentrates her practice on wide-ranging
Although Ponzi schemes are simple in theory, they have grown
complex commercial litigation and dispute resolution matters
more complex and larger in recent years. Unfortunately, most
in areas including financial services, employment, intellectual
investors still haven’t learned the lessons that the mega-Ponzi
property, real estate, securities, and bankruptcy. Ms. Alter can be
schemes should have taught. Once again, in today’s surging
reached at +1.212.905.1501 or alter@butzel.com.
markets, investors may lower their guard when it comes to
protecting against fraud. However, investors should be careful to
Joshua E. Abraham, Esq. is Of Counsel in the New York office
recall these recently learned lessons:
of Butzel Long, P.C. He concentrates his practice on litigation
and corporate advisory work. Mr. Abraham can be reached at
nGo back to the basics: diversify, diversify, and
diversify. It is not often prudent to put the majority of
your investment and/or your retirement money into a
single investment. Proper diversification will not only
guard against market fluctuations, but may also help in
case one of those investments turns out to be a
Ponzi scheme.
nIf an investment appears to be too good to be true, it
generally is. Never believe that higher returns can be
achieved without higher risk.
nNo matter how well connected or highly recommended
someone comes, always do your own due diligence.
Request audited financial statements by reputable
auditors and review/confirm underlying documents.
nKnow where your money is. Ask for monthly statements
and confirmation as to where your money is being held.
Ideally, the money should be held in a reputable thirdparty custodial account.
+1.212.374.5370 or abraham@butzel.com.
Neil Steinkamp, CVA, CCIFP, CCA is a Managing Director in
the Dispute Advisory & Forensic Services Group at SRR. He
has extensive experience providing a broad range of business
and financial advice to trial lawyers and in-house counsel. Mr.
Steinkamp’s experience has covered many industries and matter
types resulting in comprehensive understanding of the application
of damages concepts and other economic analyses. Mr. Steinkamp
can be reached at +1.646.807.4229 or nsteinkamp@srr.com.
The authors would like to thank Charles Dender, Esq. and Mark
Patten, CPA for their contributions to the content of this article.
This article is intended for general information purposes only and is not intended to provide,
and should not be used in lieu of, professional advice. The publisher assumes no liability
for readers’ use of the information herein and readers are encouraged to seek professional
assistance with regard to specific matters. Any conclusions or opinions are based on the
specific facts and circumstances of a particular matter and therefore may not apply in all
instances. All opinions expressed in these articles are those of the authors and do not
necessarily reflect the views of Stout Risius Ross, Inc. or Stout Risius Ross Advisors, LLC.
nFinally, if you suspect that your investment is a Ponzi
scheme, withdraw your money and create a record as
to what you contributed and what were your net gains.
You may want to set the net gains aside in the event of a
clawback action.
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